Today, the National Federation of Independent Business and the S Corporation Association released a new study showing that S corporations pay the highest effective rates of any business type.
The study, authored by Quantria Strategies, LLC, compares the tax burden different business entities will shoulder in 2013 and finds that S corporations will pay the highest average effective tax rate (31.6 percent of their income), followed by partnerships (29.4 percent), C corporations (17.8 percent) and Sole Proprietorships (15.1 percent).
The results of this study come at a critical time for tax reform. Ways and Means Chairman Dave Camp and Finance Committee Chairman Max Baucus have made clear they intend to spend August crafting their respective tax reform plans. A better understanding of exactly who pays what will help them construct a more thoughtful and successful reform. As the study states:
While many people think of the statutory tax rate when they consider the effect of federal income taxes, the reality is that the statutory tax rate does not represent the best measure of the effect of taxes on a business. Average effective tax rates are a better measure of whether a particular industry or business form faces greater or lesser federal income taxes relative to other industries or business forms.
This is only the second time the tax burden of S corporations and other pass through businesses has been measured. A previous study by the folks at Quantria looked at firms under $10 million in receipts and came up with similar results. Every other attempt to measure effective tax rates, however, has focused exclusively on publicly-traded C corporations. As such, this study sheds important light on their respective tax burdens and policymakers should pay attention.
According to the study, S corporations will pay the highest effective tax rate of any business type in 2013: 31.6 percent. Those S corporations making more than $200,000 will pay 35 percent! In other words, the effective tax rate on successful S corporations is equal to the marginal tax rate paid by the most successful C corporations.
Moreover, the study shows that the S corporation tax burden is highly progressive, with the smallest S corporations paying 19 percent in tax, while the largest pay 35 percent. The progressive nature of pass-through taxation is one of the reasons we argue that pass-through taxation is the best means of taxing business income.
This study makes clear that pass-through businesses, especially S corporations, are paying their fair share and then some. Remember, their tax rates just went up January 1. That’s why the pass-through community is united behind the principle that reform should restore marginal tax rate parity to the tax code, so that everybody pays the same top tax rate. This study makes clear that effective tax rate parity should also be a goal.
Key members of the Ways and Means Committee understand the importance of measuring effective rates. As Congressman Dave Reichert (R-WA) stated:
The study released today by NFIB and the S Corporation Association makes clear that comprehensive tax reform is the only way to ensure we make the tax code more fair and equitable for all employers. We know Main Street businesses employ most of the workers, and this study shows they pay lots of taxes too. The President’s plan to raise their taxes further in order to cut tax rates for big business is simply a non-starter. Tax reform needs to be comprehensive, and it needs to level out the tax burden paid by businesses of all types.
Rep. Tim Griffin (R-AR) also had this to say:
This study confirms what many Americans already know: Our broken tax code is too complex and imposes an unfair burden on small businesses, the lifeblood of local economies. And with even more taxes kicking in thanks to Obamacare, we must act quickly to create a fairer, flatter, simpler tax code that encourages job growth and is easier for millions of hardworking Americans to understand.
Coupled with previous Ernst & Young studies measuring pass-through employment levels, the threat of corporate-only tax reform to the pass-through community and the adverse effects higher marginal tax rates on employment and investment, this study is going to be a centerpiece of the on-going advocacy efforts of the S Corporation Association and all the trade groups representing pass-through businesses.